Market Likely to Drop No Matter Who Wins

Will the election affect the stock market? Sure, but not in ways that most people predict.

If history is any guide, the market probably will take a fall of about 15% in the major averages next year no matter who wins. That translates into a 1,000-point drop in the Dow Jones industrial average or a retreat to about 14 times earnings for companies now selling at 17 times earnings.

Investors’ nervous reactions about the outcome of congressional as well as presidential races will influence the market, but fundamentals of the U.S. economy will determine long-term direction.

Therefore, it will be important for investors to understand the real economic challenges facing the president, from trade to Social Security, as they keep an eye on stock-trading sentiment.

If a Clinton victory sweeps Democrats back to control of the House of Representatives, the market will be unsettled because the new House leaders will push a strongly liberal agenda--the mirror image of the Republicans’ 1994 “contract with America” that turned voters off. Investment managers, fearing bigger budget deficits, will send stock prices lower.

However, if Dole stages a comeback and wins, the market will fear the budgetary consequences of deep tax cuts and stocks will likewise fall.

The stock market would prefer a Clinton victory with Congress remaining in Republican hands, no going to extremes in either direction. And that’s the most likely outcome at this point.

Yet stocks will probably fall in any event because the market almost always does poorly in the first two years of a president’s term, whether the first term or second, says Kenneth Fisher, a Woodside, Calif., investment manager who has researched patterns back to Calvin Coolidge in 1925.

The reason is that a president must try to get the most difficult tasks accomplished in the first two years, before midterm congressional elections reduce White House options. That’s why Ronald Reagan cut inflation by taking a recession in his first two years and Clinton supported a budget-balancing program in his first two years.

What will be the tough questions in the next two to four years? The issues to watch out for are the unforeseen ones. Everybody knows Medicare and Social Security need fixing, and both parties are committed to bipartisan commissions and various savings plans to help do that.

But a big issue will be trade, as China continues to grow economically and takes on an even larger dimension in 1997 when it assumes political control over Hong Kong, with its financial and distribution muscle. “China with Hong Kong will be the low-cost producer of practically all manufactured goods, and that will affect world industry,” predicts Edward Yardeni, chief U.S. economist of the Deutsche Morgan Grenfell investment firm. “They’re not building that huge airport in Hong Kong for tourists, but for cargo.”

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The difficult task for the president will be to instruct Americans that U.S. industry’s technology is at the heart of China’s modernization, and that that therefore will be a boon to U.S. jobs--although that’s not reflected in the merchandise trade figures.

The president also will have to support investment in technology and education at home to help U.S. workers keep pace with global change. But that would be a requirement even if there never were a China.

Internet commerce will grow in the next four years, and that has serious implications for industry and the stock market. Selling by computer network is deflationary. When a company or an individual requests products and services online, bids come from all over the world.

And computers, now in the form of microchips embedded in countless products, are already holding down prices everywhere. The cost of computing fell 32.4% last year.

So global competition will get fiercer in the next four years. And that will mean lower share values for companies that still need price increases to boost profits.

A more immediate influence on the U.S. stock market will be the recovery from long recessions of the German and Japanese economies, plus others in Europe. Governments in those countries have expanded their money supplies to boost their economies. But while waiting for their own industries to respond, they invested heavily in U.S. Treasury securities, notes economist John Mueller of Lehrman Bell Mueller Cannon, a Washington-area consulting firm. Now that flow of investment will reverse and U.S. interest rates will be likely to rise.

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However, a long-term positive for the stock market is that all the suggested remedies for the Social Security system, which will start paying out more than it receives in payroll taxes in 2012, involve investment in stocks and bonds and mutual funds.

In a new book, “Promises to Keep,” Marshall Carter, chairman of State Street Bank & Trust Co. in Boston, advocates “personal Social Security accounts” in which individuals would invest the money they now pay in payroll taxes in mutual funds to finance their retirement themselves. “The funds would invest all over the world so that U.S. workers’ retirement would be tied to the increasing productivity of global industry,” says Carter.

That’s but one of many ideas that will be discussed as Medicare is rescued and changes are made to finance Social Security. Those are not simple tasks, to be sure. But they will be accomplished because what needs to be done--resources allocated, retirement ages adjusted, supplementary income funds created--depends not on economic knowledge but on political courage and wisdom.

And that’s what elections are supposed to discern.

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Meanwhile, though, it’s important for the president, Congress and investors to remember that the U.S. economy has greater possibilities ahead of it than any in the world. For perspective, economist Yardeni reports, he looked into Adam Smith’s “The Wealth of Nations.”

“I asked myself why did this guy write a long book like this in the 1770s,” he says. And he found that Britain then was terribly worried about economic decline “just when it was about to lead the world into the Industrial Revolution.”

Today, the United States is leading the world into the Information Age. That’s probably why the stock market is above 6,000. The election outcome will have some effect on that reality, but not a whole lot in the long run.